Your Exit Strategy

Tom Johansmeyer
How you sell an adult entertainment company is about to change: Instead of looking to the next generation of family or a group of outside buyers, you may consider your employees, a private equity fund or the investing public.

Larger private businesses, especially those with more than $10 million in annual sales or 100 employees, have choices, but it's not so easy for smaller companies, since those owners are stuck trying to find a private buyer or convincing your kids to take over the business. If the timing is not right for a buyer or the next generation of your family, you could be saddled with your business for a while.

Especially for Internet businesses, attempts to sell a private business may be particularly difficult. Smaller employee populations with particular expertise and founder loyalty may not adjust well to new leadership, or they could pose a competitive threat to a new buyer — given the portability of Internet business and technology skills. Family businesses may not interest the family and outside buyers will haggle you to death on the price.

Larger private companies, outside and inside the adult industry, struggle to find prospective buyers with sufficient capital. Yet mainstream businesses have found alternatives — creative ways to dispose of private businesses without substantially cutting the sale price. By selling your business to your employees through an Employee Stock Ownership Plan (ESOP), you can control the terms of the deal and dispose of your business over as much time as you need. You can mitigate a competitive threat, increase employee productivity and morale, and still sell your business effectively.

Employee-Owned Business
There is a large group of potential buyers that comes to your offices every day, namely the people who know both your market and how your business functions within it. They are the people you hired to work for you. After all, that is exactly what you have done. So, why not sell your business to them?

In your employees you can find a ready buyer, and distribute the cost of the deal over a broader population and structure the deal over a period of years while you retain control. As a result, you can mitigate the business risk inherent in structured deals by retaining control and by selling the business to people who have the expertise to operate the it with a vested interest in its success. As you sell the business over time, you are less likely to see revenues evaporate and jeopardize the income that you expect to receive. By staying in control, any loss of revenue or business inefficiency ultimately is your fault.

Using an ESOP you can structure the gradual sale of your business. Employees can receive shares in the company as part of salary, bonus compensation or in their 401(k) plans (as matching contributions). Every time you give shares of your company to your staff, you affect a partial sale of the business.

For businesses with fewer than 1,000 employees, ESOPs remain relatively untapped. According to the National Center for Employee Ownership (NCEO), only 0.1 percent of employees in companies with fewer than 100 staff members hold company stock in their 401(k) plans. Use of company stock in 401(k) plans improves to 1 percent for businesses with 101 to 500 employees and 4 percent for those with 501 to 1,000 employees.

Compare these figures to those of larger companies; 25.6 percent of employees in businesses with more than 5,000 staff members have company stock in their 401(k) plans. Larger companies are more likely to be publicly traded, generate more revenue, and support the disposition of the business through an ESOP. Thus ESOPs typically are perceived to be programs for major corporations.

Despite the current rates of ESOP participation — skewing heavily toward companies with more than 5,000 employees — this method of sale can be adopted by small businesses as well. A larger employee population certainly makes the process easier but it still is possible to sell through an ESOP as long as you plan ahead. Just keep in mind that you do not actually receive cash for the sale of your business through an ESOP. Instead, you retain cash that you would have had to pay as employee compensation.

Have your accountant keep score — this savings is the payment that you receive. Take it out of the business and invest it appropriately. You are receiving payment now for a sale that may purposefully take decades to complete.

ESOPs are not for everybody, as the NCEO data shows. While ESOPs are most appropriate for companies with more than 100 employees, plan for a longer sales cycle, because the smaller employee population may lack the financial capacity to buy as much of your business every year. It may take twice as long to dispose of a company with 50 employees through an ESOP than it would for a company with 100 employees.

When ESOPS Make Sense
If you have time to sell your business and suspect that it may be difficult to find a buyer, an ESOP may solve the problem. Since it may take 10 years or longer to sell your business, you will have to make some important decisions well in advance of your planned exit from the company — the first being determining when you plan to leave.

Once the ESOP process is in motion you will not be able to turn back (unless you repurchase the shares of the business that you sold through the ESOP). For most, the plan is to sell a substantial portion of the business to the staff by the time you reach retirement age, though younger entrepreneurs may want to structure a long-term exit strategy that is not linked to retirement. Changing your mind a few years before retirement (or other divestiture landmark) will lead most often to disappointment.

In deciding to implement an ESOP, you are deciding who will not own your business. Selling the company to your employees means that your children will not inherit it. Instead, they will receive the proceeds of the sale that have not been used prior to your death (unless you gift them). To execute your ESOP properly, you may have to make this decision before your children are adults, though a shorter ESOP period (e.g. 10 years) may alleviate this concern.

But an ESOP brings with it a unique advantage. As owners of the company, according to NCEO, the staff becomes more productive — they have something at stake. While most employees work strictly for a paycheck, employee-owners also work for the growth of the business. Selling a few more subscriptions or DVDs makes a difference to them. Thus they tend to work harder, generate better ideas, and commit more fully to their jobs.

It can be difficult to find a buyer for an adult business, especially a large one. Using an ESOP, though, you find a ready buyer and provide incentive to your staff. Your business will gain value through improved productivity and you will be able to get a better price for your business. Instead of finding a buyer and structuring a sale, you can sell to adult insiders who know your market.